Deontology and Consequentialism in Standard Setting

How often do we get to use big esoteric words from philosophy when we are talking about accounting standards? Not often enough!

Usually, the only philosophical terms we use are ‘normative’ and ‘positive,’ and I think many of us are pretty comfortable with the notion that standard setters are trying to answer normative questions (what should we do), and that academic researchers can help out by providing positive evidence on what happens, how it happens and why. (My thoughts on that in this post, called Unabashedly Normative).

Thinking more about the issue leads me to note a different but related distinction between two ways of thinking about the what standard setters should do. In the philosophy of ethics (the mother of normative questions), people distinguish between deontological and consequentialist methods of answer the question of what people should do.

Deontology (the science of duty) looks to intrinsic definitions of good and bad actions without reference to the consequences of those actions. For example, arguing that lying is bad because it is forbidden by the 10 commandments would be a deontological argument. In contrast, consequentialists would argue that lying is bad because it causes bad outcomes (a lack of trust, which leads to the breakdown of society, etc.).

Discussions at the Financial Reporting Issues Conference make me think that standard setters start with a largely deontological view of financial reporting, with the duty imposed by the conceptual framework. (I understand that IASB members sign a contract agreeing to pass standards that are consistent with the framework.) The Framework’s asset-liability view imposes quite a bit of discipline on the process of determining standards. Specifically, it provides a straightforward four-step approach to determine an appropriate accounting treatment for a particular transaction:

Determine when assets and liabilities should be recognized and derecognized, according to the Framework’s definitions.

Determine how to measure those assets and liabilities when they are originally recognized, and when and how to remeasure them.

Determine how to assign net balance-sheet changes to income statement line items. Does a change result in revenue or some other gain, or cost of goods sold, operating expense or loss?

Finally, determine how to present the balance sheet and income statement. On the balance sheet this often becomes a question of net vs. gross presentation of items that include both a debit and a credit (such as a forward contract, property with accumulated depreciation). On the income statement, this is often a question of the degree of disaggregation, and the placement of the information.

This process is deontological, because it looks to the intrinsic nature of the transactions to determine what the standard setters should do, without reference to the consequences of the ultimate standard. To some extent adherence to the deontological argument seems likely to result in good consequences — or at least one can say that deviations from this process might result in very bad consequences. However, it does not directly address some of the most important consequences of standards. For example:

Will the standard result in better investor decisions?

Will the standard distort commercial arrangements as preparers rewrite contracts to get better accounting treatments?

Will the standard allow firms too much ability to manage earnings through distortion of unverifiable estimates and judgments?

Will the standard result in such complex standards that users won’t understand them?

Will similar transactions be treated so differently that users won’t be able to compare across firms?

As Jeffrey Hales pointed out in today’s roundtable discussion, debates over steps 1 and 3 tend to be most deontological because we have reasonably precise definitions of assets, liabilities and many income statement accounts. However, 2 and 4 don’t currently benefit from definitions. But that leaves the question: are the current deontological arguments also leading to good consequences?

That is a job for positivists!

Robert Bloomfield

Robert Bloomfield is the Nicholas H. Noyes Professor of Management and Accounting at the Johnson Graduate School of Management at Cornell University, where he has taught and conducted experimental research since 1991.

Like this post?

If so, would you please consider sharing it with the world.

One comment on “Deontology and Consequentialism in Standard Setting”

I disagree with the assertion, in this post, that we have reasonably precise definitions of the fundamental elements of accounting, in particular of the concept of assets. The economist Irving Fisher suggested in his book The Nature of Capital and Income (1906, 103) that a good definition should satisfy two conditions. First, it should be useful for scientific analysis. This requires that the definition be useful for classifying objects. Therefore, the definition must be capable of determining whether items fall within a particular class of objects or should be excluded from that class. Second, the definition should be consistent with a common-sense understanding of the term. The current asset definition fails on both counts.

Two prominent critiques of the FASB’s asset definition may be found in: What is an Asset? by Walter Scheutze and The Concept of Assets in Accounting Theory by Richard Samuelson. Scheutze writes that the asset definition is “so complex, so abstract, so open-ended, so all-inclusive, and so vague that we cannot use it to solve problems.” He further states, “The definition does not discriminate and help us to decide whether something or anything is an asset.” In his view, the existing FASB definition describes “a large empty box” that is so open to interpretation that “almost everything and anything can be fit into it.”

Samuelson also identified several weaknesses with the FASB’s definition of assets. Perhaps, the most damaging is that the definition confuses stocks with flows. In the FASB’s definition, assets are defined as future economic benefits, which are events expected to occur over a period of time; however, assets exist at a particular point in time. In other words, assets are stocks, not flows. What exists now is an expectation of future benefits, a right to future benefits, or a source of future benefits. Expectations are in the mind of the measurer and have no independent existence. If assets are defined as “future economic benefits,” the focus is on future events that are inherently unverifiable. Thus, the current asset definition lacks empirical content because it does not link the “future economic benefits” expected to be generated to anything that currently exists.

In summary, the FASB’s asset definition is not adequate for the development of principles-based financial reporting standards because it isn’t useful in determining whether something is or is not an asset and it is inconsistent with any common-sense understanding of the term because it is not expressed in terms of something that currently exists.

Ask A Question

Do you have a question for FASRI? Are you wondering what the FASB is proposing on a particular issue, or why? What research has been done on a standards-related topic? Are you looking for advice on your own standards-related research?
Email one of the editorial board members , and we'll try to get you an answer.

Disclaimer

The Financial Accounting Standards Research Initiative is funded by the Financial Accounting Foundation,and is overseen by Staff and Board members of the Financial Accounting Standards Board. However, neither the contents of this website, nor any remarks made during FASRI Round Table Discussions, nor any research or other reports published by FASRI officers, nor any research or reports written after receipt of consultation or funding by FASRI, reflect official positions of the Financial Accounting Standards Board.

Official positions of the FASB are reached only after extensive due process and deliberation.